Smart-beta index exchange traded funds have helped investors capture attractive returns in the European equities market.
As European economies move out of a recession and back into growth, smart-beta European ETFs with a heavier tilt toward smaller companies has outperformed traditional beta-index ETFs. [European ETFs Strengthen But Watch Out For Trouble Spots]
For example, the WisdomTree Europe SmallCap Dividend Fund (NYSEArca: DFE) is up 8.0%, First Trust Europe AlphaDEX Fund (NYSEArca: FEP) gained 6.7% and First Trust STOXX European Select Dividend Index Fund (NYSEArca: FDD) increased 8.9% year-to-date. [First Trust Eyes Europe Expansion]
In comparison, the traditional market-cap weighted Vanguard FTSE Europe ETF (NYSEArca: VGK) is 4.1% higher year-to-date.
“As the markets emerge from a recession, smaller and mid-cap stocks do better as they’re more tied in with the local economies,” Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ, said in a Reuters article.
Rules-based, factor-based, intelligent, enhanced, fundamental or smart-beta index ETFs employ screening techniques that select companies with specific qualities. For instance, the ETFs may screen for factors like dividend yield, sales growth or stock price momentum, among others.
Consequently, the screens make these ETFs lean toward small- and mid-capitalization names.
For instance, FEP market-cap weights include mid-caps 24.8%, large-caps 24.2% and mega-caps 9.1%; FDD weights include mid-caps 37.6%, large-caps 34.6% and mega-caps 27.8%. On the other hand, VGK includes 56.8% in mega-caps, 31.9% in large-caps and 11.2% in mid-caps.
The quick growth in these strategic beta or alternative beta index-based ETFs allow investors and advisors to make more targeted investments in European markets. Additionally, studies have shown that alternatively weighted indices have outperformed market cap-weighted indices by as much as 2% per year between 1969 and 2011.
“Both institutional and retail investor interest in these strategies have accelerated in the past several years,” a group of Moody’s analysts said in a recent report. “It still has substantial room to grow.”
Nevertheless, smart-beta ETFs are not without their risks. During a broad market sell-off, or a risk-off environment, riskier small-caps will take a hit. [Institutions Warm to Smart Beta ETFs]
“If the European economy shows signs of weakness and or certain local European markets show signs of weakness, then these ETFs because of their smaller-cap nature are more likely to get hurt,” Rosenbluth added.
For more information on Europe-related ETFs, visit our Europe category.
Max Chen contributed to this article.